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Tuesday, 28 November, 2017

The Benefits of Outsourcing Funds Administration

Alternative investing has gone from a gold-rush industry to one of market turbulence, regulatory oversight, and intense competition. In turn, fund administration has transformed. What was once a relatively straightforward outsourcing of fund accounting has now become a more complex and tailored delegation of operational expertise that requires savvy professionals and sophisticated IT at the ready. Hedge funds were early adopters of outsourcing, but now private equity managers are responding, by outsourcing a variety of functions, in order to quickly gain know-how and increase efficiency.

Today, outsourcing is an accepted and growing practice in private equity globally, and investors are also a big part of the reason why. According to Johannes Nölke, Managing Director, Alternative Investments, at Vistra Germany, institutional investors, as well as regulators, are looking favorably at the outsourcing of a fund’s administration functions.

Nölke adds, “Regulatory requirements, the need to show independence and deliver exceptional levels of service and transparency to investors are the major trends that are driving the need to outsource.” Julian Carey, Head of Client Services-Associate Director at Vistra Guernsey, agrees, noting that the growing complexity in reporting and regulatory requirements makes administration in-house more and more expensive. Plus, outsourcing to a third party administrator can be charged back to the LPs, he adds.

The Push by Investors

As institutional investors allocate more money to private equity, investors are undertaking more detailed due diligence and review of the fund’s operating practices, says Malcolm Pobjoy, Group Commercial Director, North America, at Vistra. “Investors are demanding higher standards for reporting and transparency, independent administration, reduction in key employee risk, and lower fund operating costs. These are the predominant factors driving the increased adoption of outsourcing.”

Broadly Accepted

Data on the industry indicates an increasingly deep penetration of outsourcing in the private equity community. Vistra’s report, titled “Private Equity Fund Governance: Establishing Best Practices 2017—The Manager & Investor Perspective”, found that more than 50% of the GPs interviewed outsource some of their administration to third-party providers, and nearly 40% of those expect to outsource more functions in the future. They also note it “helps them access specialist skills and is more efficient, especially for those with a global footprint”.

According to Marcia Rothschild, Business Development Director at Vistra North America, emerging fund managers are particularly interested in outsourcing funds administration. She notes, “Emerging managers that launched fund 1 successfully are now working on fund 2 and 3, and they’re realizing they won’t be able to cope with the infrastructure they have.” That’s when outsourcing becomes very attractive. Plus, she says, “Large managers that don’t outsource realize they can’t keep adding people to their back office in order to scale, as the processes are very manual.”

Outsourcing Not for All

Of the GPs resistant to outsourcing, they list “cybersecurity concerns, a lack of flexibility, increases in fees by administrators in some jurisdictions, staff turnover, and the fear of trusting an external provider” as the reasons for not outsourcing.

According to Malcolm Pobjoy, Group Commercial Director, North America, at Vistra outsourcing is not a one size fits all. “We see managers who have the capability, scale, skill and hands-on mentality to provide administration services in-house, but the bar for justification of keeping this in-house is being raised all the time.”

The Right Time to Outsource: Scale and Skill

The size of the fund might dictate whether or not to outsource. Once a PE firm reaches a critical mass and feels growing pains, it’s usually the time to look for a third-party administrator. According to Gretchen Perkins, Partner at Huron Capital, running a large private equity firm is “an administratively intensive practice”. As firms increase in size and number, talent becomes a precious commodity.

Often, she says, PE will outsource simply due to a lack of manpower, especially when they might need the bandwidth for more important functions. Investor demand for independence and institutional level infrastructure are also motivating factors. Plus, Perkins acknowledges that LPs do appreciate what a third-party brings to the fund by keeping the books and records at arms’ length.

Whatever the reason, it appears the PE industry will follow the hedge fund industry, with funds attracting institutional investors likely to outsource their fund administration.

Further insights on the current state of play in the private equity fund governance market from both an industry and investor perspective can be found in our 2017 Private Equity research report. Click here to download the report.